Englund, David J.

Fausti, Scott W.

Murra, Gene E.

English

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South Dakota State UniversityOpen PRAIRIE: Open Public Research Access InstitutionalRepository and Information ExchangeEconomics Commentator Department of Economics3-31-1998A Look Into Producers' Decisions to RetainOwnership of Cattle; Risk ManagementDavid J. EnglundSouth Dakota State UniversityScott W. FaustiSouth Dakota State University, scott.fausti@sdstate.eduGene E. MurraSouth Dakota State UniversityFollow this and additional works at: http://openprairie.sdstate.edu/econ_commPart of the Agricultural and Resource Economics Commons, and the Regional EconomicsCommonsThis Newsletter is brought to you for free and open access by the Department of Economics at Open PRAIRIE: Open Public Research AccessInstitutional Repository and Information Exchange. It has been accepted for inclusion in Economics Commentator by an authorized administrator ofOpen PRAIRIE: Open Public Research Access Institutional Repository and Information Exchange. For more information, please contactmichael.biondo@sdstate.edu.Recommended CitationEnglund, David J.; Fausti, Scott W.; and Murra, Gene E., "A Look Into Producers' Decisions to Retain Ownership of Cattle; RiskManagement" (1998). Economics Commentator. Paper 354.http://openprairie.sdstate.edu/econ_comm/354IECONOMICSCOMMENTA TORSDSUSOUTH DAKOTA STATE UNIVERSITYA LOOK INTO PRODITJERS' DECfSIONSTO RETAIN OWNERSHIP OF CATTLEbyDavid J. EnglandEconomics JnstnictorandScott W. Fausii.isHociate ProfessorBeef has ioat tnarket share in total meatconsumption over the las^t two decades. This hascreated financial problems for iTtany sectors of theinditstry. iriciuding producers, fividenee suggests thatretained ownership can l.>e a partial solution. Retainedownership can increase producer profit per head andimprove quality control, leadittg to greater consumersatisfaction and increased market demand.However, retained ownership practices are not foreveryone. It is important to identify the factors thatlead producers to practice retained ownership, '.f'hesefactors can he useful to others in providing insight intothe decision process of producers adopting thepractice.MethodologyIn this study, a statistical procedure called conjointanalysis was used to identity the attributes that leadprodttcera to the retained ownership decision.Traditionally, conjoint analysis is a measnrernenttechttique u,sed to study ccmsumer quality evaluations.h product is divided into the attributes tliat make upthat product, iheti the pan-worths of each of theseatsrihures are calculated and sitmtned to arrive at thecotisumerks overall satisluction for the product. Forexample, an apple could be broken down into thecharacteristics of size, svveetness. price, crispness,{Continued on page 2)No. 385 March 3h 7998RISK MANAGEMENTbyGene E. MurraProfessor EmerirusBy Spring, mo.^t livestock and grain producersknow whether or nor the dectsions made the precedingFall to retain ownersiup of their product was a good(ptofnable) one. For cxampie. they know if the calvesthey duinh .ceil as weaned calves in the Fall earnedthem more protit when they were sold in March, Or,the corn, soybean or wheat producers krmw if it"patd" to store gramMany producers in .South Dakota do not make"retained owner.ship" decisions in tlte Spring.However, that may be a good time to think aboutpossibilitie.s for the Fail, especially if a lettder isinvolved. Some flexibility regarding sales dates mayl>e de.sired.Retained owttership of any commodit)' longer titan"norm-al" involves added risks. In general terms, nskcan be divided into production risk and price risk.Certainly, producer.s face both types of risk, .hist ascertain, some of those risks can ise managed and, insome cases, almost totally eliminated. This does notimply that total elimination of risk is desirable.Production RisksWhen a producer decides to maintain ownership ofhis/her product longer than nonnal (for example, don'tsell calves or soybeans in November but backgroundor store until March), there are production risks. ThefollQwlug list includes only some of those risks.(Continued on page 3)Page 1{A i.ook coatinued from p.l)and color. A consumer's overall perception of anapple would then tx; estintated based on preferencesfor the characterisocs. It would be pos.sible to findwhich attributes of ari apple are more important and byhow mneh. Here, cottjoiut analysis was used on thesupply side, to identify' decision making attributes ofproducers on the issue of reiaitred ownership.f)ata for this re.scarcb were collected through amail survey conducted in the spring of 1997. Thestudy population consisted of the 248 cow-calfprttducers involved in the South Dakota StateUniversity retained ownership demonstration project.Attributes used on the maitt survey were obtainedthrongh a presurvey .sent to 25 randotnly selectedproducers. A.s a result, the final list of attributes to beu.sed on the main survey were calf prices at weaning(high / iow). cattle futures price (high / low), expectedrate of gain (good ! pcmr). expected cost of gain (high.' low), and availability of futids (cash or fmancing)(dtfficult ' accessible).After the questionnaires were analyzed, foursegmented studies were performed on the studypopulation. Each segmented study separated theoverall group into two .sub-groups based on respondentcharacteristics. The .sub groups of the tlrst .segmentedstudy were producers who have retained ownershipoutside of tlte SDSU e.xperimental program, and thosewho never have. The second segmented studyseparated producers who belong to sotne type ofindustrial association from those who do not. Thethird segmented study separated producers by whetherthey had or had not panlcipated in extension programsother than the SDSO program. The fourth segmentedstudy separated large producers from stnall producersby whether they were under or over an average ofSlTS.OiX) in total farm sales over the previous 3 years.ResultsExpected rate of gain ranked as the most importantattribute in every study, regardless of respondentsegmentation. Two reasonable hypotheses for thisresult are: 1) relative to the other attributes listed inthe questiotmaire. producers have the most controlover expected rate of gain; and 2) it has the mostimpact on profit.Availability of funds was considered tlie leastimportant attribute by such a iarge degree that it wasnegligible in every study Two possible explanationsfor this result are: i) producers may consider thisattribute pertains more to the liberality of the bankingconrmunity than to their own decisions; and 2) havingfunds or not would certainly aftect the feasibility ofoperations, however, have very little impact on profit.Tiie two prtxlucer controlled attributes (expectedrate of gain and cost of gain) were consideredrelatively more important than the two market priceattributes (calf prices at weaning and cattle futuresprice) by every group. A possible explanation, ottceagain, is a combination of prtxiucers having the mo.stcotitrtil over these attributes and these attrihute.s havingthe greatest impact on profit.There was little difference between the relativeim.ponance of the top four attributes in any of thegroups (i.e. , expected rate of gain, calf prices atweaning, cost of gain, and cattle ftitures pricei.Again, profitability is probably the issue, la theproducers' opinion, these four attributes wouldcontribute equally to profit.Tt was expected that producers involved withassociations and producers involved with Extensionprograms would provide similar results because bothgroups participate in educational programs. However,there were two exceptions to this expectation.Producers involved in Extension prograims attributedmore relative importance to calf prices at weaning thandid producers not involved with Extension. However,it was prtxiucers who do t^ belong to an associationwho attributed more relative importance to calf pricesat weaning than producers who belong to anassociatitm. .A .similar contradiction occurred with theavailability of ftmds attribute.The two .segmented groups, prtxlucer.s who haveparticipated in retained ownership and tho.se who havenot, showed almost identical results. Also, in moststudies there was very little difference in the relativeimportance of tlie four most important attributes.These two facts suggest the possibility that someoverriding attribute may have been missing in thestudy. One .such attribute might be tradition. Thisattribute would specify* that producers either retainownership or not because they have traditionallyoperated their business in such a way. It has beennoted in previous research that many cattle producersconduct their operations the same way every yearregardless of market conditions. Unfortunately, thestructure of the questionnaire did not allow this is.sueto be inct.>rporated.In conclusion, producer controlled productionvariables are of greater importance in the retainedPage 2ownershipdecision than cattle prices, and ftnaticialfeasibiUty seesrss not to play a role.^jit ;J< JiJ y jf:*J^S ** *(Ri.sk management ... continued from p.I)i Poor performance - In spite of everything aprcKiUcer does, some cattle "do not perform well"'.There are a number of reasons for this situatiotpincluding cattle genetics, feed availability and quality,health problems, and death of the anitnai (the ultimatepoor performance). While some factors can becontrolled to some extent, many prrxiucets do notknow "how their cattle pterform" after they leave thefarnt or ranch. They never have followed their cattle!o the backgrounder and.'or feedlot. They think theircattle will perform but don't know for sure. A quickand dirty recomtnendatlon is "find out more aboutyour cattle before you keep them around longer".While grain in the bin, if .stored correctly, shouldjtot face production risk, there still could be a problemWith maintaining quality. What wetu into the bin maynot always be what comes out.2. Costs greater tlian expected - For livestock, tltiscould be because of factors noted above and/orchanges (increases) in input prices. If inputs arepurchased, forward pricing of those inputs can, insome ca,ses, be used to help control co,sts. Aneffective rnanagement program can help reduce therisk of higher costs in some cases. Unfortunately,some producers who retain ownership for the first timemay not follow an effective ntanagement program.Grain producers often "forget" one of their majorcosts " interest. Grain sold at harve,st yields dollars.Those dollars could be used to pay off loans. EvenS3.60 wheat used to pay off a 10% loan saves 3C perbushel per month in interest charges.3. Weather - Weather can affect btidi grain andlivestock prrxJucers. It is easy for cattle producers inthe Northern Plains to remember the Winter andSpring of 1996-97. Biixzards, snow, ice and very coldremiperatures had tlteir impact. While we cannotcontrol the weather, management techniques can beused CO help offset some of the impacts of weather. Insome cases, this will require capital investment inbnilding.s, equipment, and feeding areas.Grain producers with grain in the bin also wereaffected by the 1996-97 Winter. Often, a lot of effort(including dollars) was expended just to get to the bin.Then, by Spring, .soft (or under water) roads addedcosts to get the grain to market (if you could get thereat all).4 Other enterprkses - Retaining ownership requiresresources. The demand for those resources may havean impact on odter enterprises. Pre-planning probablywill be required to keep confiicts to a minimum.In total, retained ownership carries productionrisks. If you have not practiced retained ownership inthe past, these risks probably are greater than for thosewho have followed the practice before. A goodmanagement program may be the best totrl one can useto manage production risks.Prke RiskThe longer one retains ownership of a product (acalf or grain), the greater the chances for prices tochange. Tho.se changes are not always "up". Or,price decreases may be greater than expected. Unlikeproduction risk, there are strategies which can get ridof all price risk. But, these may be too expensive to"leave anything for profit". There also are strategieswhich shift part of the price risk. Several strategies,along with a brief statement regarding what each doesand does not do, are presented below.I- Sell now - Selling calves or grain now (now couldmean .sell weaned calves in the Fall or grain atharvest) gets rid of all price and prtxluction risk at thattime. It is the "safest" strategy (in terms of risk). Itis easy to use. ft has been used by many producersfor years. It will continue to be used for many years.It is not a bad strategy for tnany producers,2. Cash forward contract - Once a cash forwardcontract is signed, price risk is gone. Both lower andhigher prices are "locked out". However, productionrisk still is there. After all, a cash forward contractusually is an agreement now between a buyer andseller for the later delivery of a product (calf or grain)but at a price agreed upon ttxlay. The futures marketcan be used to "evaluate" a cash forward contract.3- Sell futures - Once a fotures contract is sold, pricerisk Ls reduced to "basis" risk. In a sense, productionrisk is removed since a futures contract once sold canbe "bot" back and no delivery is required. In anotherand more important .sense, however, production isrequired for a "true hedge" to be in place.Often, basis risk (the difference between yourprice and the futures price at the time of your cashsell) is much less than the price risk. However, recenthistory ha,s shown there can be considerable basis riskPage 3for feeder earde For exarnpie, snanv feeder calfproducers assusmr a pasirive basis for sprdrg-borR andfall-sold calves. In effccr, rhey assume that lightcalves {5('X) lbs) are worth more per hundredweightthan heavy calves {750 Ibs-che appropriate weight fora feeder cattle futures contract). When corn prices gotoo high (as in 1996), lighter calves are discounted andthe assumption of a positive basis was itt error attd a'dower price than expected" was received.Selling futures does provide a minimum price and"locks out '̂ higher prices. Also, there are marginrequirements. Those who understand futures know that- those who don't should learn about ftimres. In short,if you have sold futures for ottly part of your expectedproduction, margin calls itsually should be welcomed.4, Other techniques - There are other techniqueswhich can be used to manage risk Only a fewcominetjts about some of them are presented below.The briethes.s of the comntents does not imply lack ofimportance. It does point to the need for producers toicarn more about them in a more "educational" setting.Buy puts - Here, insurance is purchased against"lower prices". Tlie "insurance" has a cost (premium)and is used to purchase price fltmrs but at the sametime leave the ceiling open. Buying puts does notremove basis or prtKluction risk (see comments onprrxluction risk under the "sell futures" discussionabove). There are no margist requirements. This isimportant to imny producers and lenders.h. Fence - This strategy involves the purchase of aput and the sale of a call. A range of prices isestablished. There still is basis risk attd productionSOUTH DAKOTA STATE UM"VTRSITTEconomics DepartmentBox 504ABrookings, SD 57(X)7.Address Correction Requestedri.sk. Net premtum costs usually are close to zero butmargins may be required. Producers should beknowledgeable on futures and options before u.stng ac Synthetic out - For the cattle or grain producer,this could involve a cash ibrward contract atni buyinga call. .A minimum price Is established with thecash/forward contract but some upward price mobilityis possible by purchasmg the call. There still isproduction risk but price and basts risk are eliminated.Premiums must be paid but there are no margin calls.While this is not an extretnely difficult strategy, itdoes require some knowledge of futures and options.d. Roll up strategies - In some cases, a combinationof .strategies can he used. One strategy, such asbuying a put, can be initiated now and then sellingfutnres could be added later. The use of thesecombination strategies can reduce price risk if usedcorrectly. Improper use cau increase price risk.ConclusionRetained ownership increases risk. Some risk canbe managed more effectively than other risk. Many ofthe pricing strategies used to manage risk requireknowledge of futures and options. Producers shouldevaluate their risk position and their knowledge ofmarketing alternatives before engaging in some of the"tnore advanced" strategies.ECONOMICS COMMENTATORECONOMICS DEPARTMENTSouth Dakota .State University Phone; (6{)5) 688-414!Sox SOaA Fax; 1605) &88-63S6Brottkiitgs, .SD .'57CXI7-OS95 E-Mail; StoverP#mg.S£ista;e,e<iu4St> copies of ttiis newjiieuer weia proooceU at a oast of iess tfim StCO

A Look Into Producers\u27 Decisions to Retain Ownership of Cattle; Risk Management

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A Look Into Producers\u27 Decisions to Retain Ownership of Cattle; Risk Management

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